5 myths in Steven Brill’s ‘Bitter Pill’ – Part 2

The AHA has already sought to set the record straight regarding Steven Brill’s expose on American health care. I earlier reviewed some of the misleading information Mr. Brill gave his readers regarding international comparisons.

Today, I want to focus on two myths that perhaps may have contributed most to the perception that Mr. Brill may actually have been shilling for a single-payer health system.

Excess Prices = Excess Profits

Pricing in the health care sector is puzzling, to be sure (though much more understandable for those who recognize the distortionary effects of third party payment in any industry, not just health care). Mr. Brill cites a flurry of instances of what the average reader might view as outrageous mark-ups, leaving the strong impression that such mark-ups leave obscene profits in their wake. Yet as Orem Cass has pointed out, nearly all of Mr. Brill’s examples are for inpatient hospital care, which generates an average operating profit margin of 2%!

Mr. Brill asserts that the operating profit of nonprofit hospitals is 11.7% without providing any context for this figure. I won’t rehash the debate between Mr. Brill about whether his figure is a better measure of profitability than the 5.5% figure favored by the American Hospital Assocation (AHA).[1] As it turns out, using a standardized measure across all industries, the profits in the health services sector are very much in the middle of the pack (or lower) compared to other industries.

This chart from my book shows that medical facilities-which includes hospitals and nursing homes (unfortunately no separate break-out for hospitals is available)-rank relatively low among the roughly 50 industries a year that are included in the Fortune 500. For example, medical facilities ranked 30th among all industries in 2008, the last year for which actual rankings are reported. This admittedly is not a picture of the entire industry: these only represent the largest publicly traded firms within the industry.

But a more representative compilation of publicly traded firms tells the same story. The pre-tax operating margin before accounting for interest, taxes, depreciation and amortization (a measure similar but not identical to that used by Mr. Brill[2]) for medical services companies is only 12.2% vs. 22.3% for the nearly 6,200 firms included in the ValueLine survey.[3] Indeed, by this metric, medical services are much less profitable than newspapers (18.0%) !

Where’s the hand-wringing over the unconscionable profits in the newspaper industry?

Likewise, if we focus on the net margin (net income/revenues, which essentially is the measure used by the AHA), medical services earn a profit of 4.66% vs. 7.84% for all industries. Admittedly, these figures do not include nonprofit hospitals that Mr. Brill says have even higher profits than their for-profit counterparts. But if the publicly traded medical services firms only make less than 5% profits, does anyone seriously suppose that nonprofits have a substantially higher profit rate?

Medicare Administration is More Efficient than Private Health Insurers

Mr. Brill offers a cornucopia of statistics to leave the impression that having Medicare is much more efficient than relying on private insurers:

Including the foregoing claims handling costs, Medicare’s total management, amount to 0.7% of claims or $3.80 per claim[4]; whereas Aetna spends $30 per claim or 29% of paid claims.[5]

First, the 29% figure is misleading since it leaves the impression that 29% of every premium dollar goes to administration, when the actual figure is apparently 22.5%.[6] Second, the figure is not remotely representative. The average for all private health insurers is only 9.2% according to a detailed study of this issue conducted by the reputable consulting firm, Sherlock Company.

But the difference in administrative costs for Medicare versus private insurers also is grossly overstated for a variety of reasons. First, administrators of Medicare’s private health plans do not have to perform as many functions as do their private counterparts (for example, marketing and provider rate negotiations). When only Medicare administrative services are taken into account, the administrative costs for private plans are cut approximately in half.

Another important reason is that the average dollar amount per Medicare claim is much higher than for private insurance because the elderly and disabled use hospital and nursing home services far more than do children or non-elderly adults. If it costs $30 to handle one claim, then administrative costs will be a far smaller fraction of spending on a $10,000 hospital claim than on a $100 physician claim. In short, it’s quite difficult to compare Medicare and private insurance on an apples-to-apples basis, leading the Medicare Payment Advisory Commission to conclude “it is difficult to determine which program administers health care more efficiently.”

One thing we know for certain: the cost of capital in the private health insurance industry pales in comparison to the cost of capital raised by Uncle Sam. Let us generously assume that profits in the health insurance industry are 7% (even though the previous figure shows they reached this level only once in the past 6 years). In essence, this means that private insurance companies have to pay investors 7 cents on the dollar to move those dollars out of their hands into the pockets of insurers to be used to build their companies. It might appear that Uncle Sam gets tax dollars for free, but in reality, every dollar of taxes (whether used to bankroll Medicare or national defense) shrinks the economy 44 cents. This is why the hidden costs of single-payer health care would easily swamp any minuscule difference in administrative costs and profits there might be between a private health insurance plan and a tax-financed public plan.

Moreover, Brill himself catalogs how Congress has placed “handcuffs on Medicare:”

For example it jumped in to restrict how research from the Patient-Centeredd Outcomes Research Institute could be used: they cannot be “not be construed as mandates for practice guidelines, coverage recommendations or policy recommendations.”

Congress likewise has not allowed Medicare to drive down the cost of durable medical equipment through competitive bidding even though pilot studies have shown this could save 40%.

Congress requires Medicare to reimburse for any FDA-approved drug regardless of cost-effectiveness. Indeed, Mr. Brill fails to tell readers that by law, Medicare is not allowed to use cost-effectiveness as a criterion in determining what services to cover. Is there any wonder we are squandering billions on treatments that provide little value for the money?

What makes good for politics far too often is not good policy. The track record of Congress in “managing” Medicare is pretty dismal: Americans would be far better served by having Uncle Sam do something that he does quite efficiently-cut checks-and let Medicare beneficiaries shop for coverage the way members of Congress and their staffs do. Instead, Mr. Brill proposes a variety of ways in which to further entangle the political process in the management of health spending across the board (not just Medicare). Readers of my blog posts should know why I am deeply skeptical of how the decision to centralize even more decisionmaking authority in Washington D.C. will play out.

Other Myths

There’s other less consequential issues on which Mr. Brill’s presentation is misleading, one-sided or flat wrong.

He assures us that “60% of the personal bankruptcy filings each year are related to medical bills” whereas more careful analysis suggests it is less than half this level.

He claims that the estimated $39.3 billion in hospital charity care is based on chargemaster prices, so may actually cost less than $3 billion to provide. In fact the American Hospital Association (which is the source of this $39.3 billion figure, which by 2011 had risen to $41.1 billion) clearly explains that it is calculated by adjusting charges to actual costs.[6]

He implies that there is much less fraud in Medicare than private insurance since “Medicare has multiple layers of protection against fraud that the insurance companies don’t because they lack Medicare’s scale.” Health policy experts have concluded quite the opposite, since fraud prevention savings go directly to a private company’s bottom line, maximizing the incentives to weed it out. Indeed, the General Accountability Office estimates that nearly 10 percent of all Medicare payments are fraudulent or otherwise improper, and further concludes that the government isn’t doing enough to stop them.

As I concluded in my first post, Mr. Brill has nicely codified much of what is wrong with American health care. He arguably has shown just how inadequately Obamacare addresses the myriad of problems he identified. But unfortunately, he also has contributed to some of the very same misconceptions that resulted in Obamacare, a very misguided prescription for what really ails the American health care system. Until we get the diagnosis right, we have no reasonable prospect of getting off the wrong track we’re now on thanks to the Affordable Care Act.

Footnotes

[1] In his first footnote, Mr. Brill defines operating profit as the hospital’s excess of revenue over expenses, plus the amount it lists on its tax return for depreciation of assets. His rationale for this is that depreciation is not an actual outlay, though many non-profit facilities elect to fund depreciation rather than have to borrow every time something needs replacing. The AHA, in contrast, counts depreciation as an expense-recognizing that capital really does need replacement eventually-and calculates operating margin as the difference between operating revenue and total expenses divided by operating revenue, i.e., (R – C)/R, whereas Mr. Brill uses (R – C + D)/R. Consequently, the AHA reports that the average hospital had an operating margin of 5.5% in 2011-well below Brill’s 12.2% figure for nonprofit hospitals (the AHA provides no break-down of how this figure differs for nonprofit and for-profit facilities).

[2] The ValueLine survey is based on EBITDA, i.e., earnings before interest, taxes, depreciation and amortization. Mr. Brill’s measure appears to be equivalent to earnings before depreciation only.

[4] Mr. Brill doesn’t report this figure but it can be calculated from his observation that Medicare’s administrative costs amount to $3.8 billion and pays $550 billion in claims.

[5] Mr. Brill reports that Aetna spent $6.9 billion on operating expenses (including claims processing, accounting, sales, executive management) and computes that this equals about $30 for each of 229 million claims it processed, or about 29% of $23.7 billion in paid claims.

[6] Mr. Brill arrives at 29% by dividing $6.9 billion into $23.7 billion in paid claims, but as a percent of premiums paid, the figure should be $6.9/($6.9 + $23.7) = 22.5%.